Increased Oil Production Does Not Necessarily Lead To Lower Oil Prices

Headlines about growing US crude oil production have been in the news a lot lately. In its annual statistical review, BP reported that US oil output surged 14% in 2012. The million barrel-per-day jump in output was the largest increase for any country in 2012, and the fastest single year increase in US history. According to the US Energy Information Administration, US crude volumes for August were at the highest monthly level of production since 1989, averaging 7.6 million bbl/d.

 Monthly US Oil Production

Although US supply has increased, oil prices remain above $100 per barrel and gasoline prices appear entrenched above $3.00 per gallon. Part of this is due to geopolitical risk and rising global demand. But, consumers may still wonder if this is yet another example of oil companies taking advantage of end-market customers.

We believe the high price results from market fundamentals. Production from the onshore oil wells, ¬†which are driving US volume growth, declines relatively quickly. It costs several million dollars to drill a new well, so it isn’t cheap for producers to maintain, let alone increase, production. In short, the process is both expensive and challenging.

As a result, we think the combination of expected demand growth among developing economies and comparatively high production costs means that average oil prices over the near-to-mid-term are likely to remain elevated.Companies that produce oil need help from service providers and rig companies to extract oil. This raises the possibility that oilfield services companies may represent an opportunity for investors.